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The benchmarks that are supposed to measure performance and create alignment with end investors are working against asset managers, and the industry must find new ways to demonstrate value before it’s too late, according to MFS.
How YFYS is reshaping investment strategies
Your Future Your Super (YFYS) will make super funds bigger and more risk averse – except when it doesn’t, according to a new report from J.P. Morgan Asset Management (JPMAM).
The report, which follows J.P. Morgan’s inaugural survey of super fund executives, shows that CIOs are now adapting their investment strategies to the demands of the YFYS performance test and that the existential threat of a second failure is driving (most) funds to more passive allocations in the public markets.
Allocations to what are usually regarded as higher alpha opportunities – small cap equities, emerging market equities and debt, and securitized credit – “will be more challenging to justify in the future.” That reduced appetite is matched by an increased appetite for greater risk taking in alternatives and unlisted assets, where there’s an opportunity to add value over the benchmarks, and a move to take positions within “niche sectors” in private markets that CIOs believe are “satellites” relative to the strategy’s respective benchmark
“Underperforming funds are currently taking larger bets on credit, and are also considering reducing unlisted and alternative investments to lower fees,” the report says. “Interestingly, the research showed CIOs of outperforming funds tend to take the opposite strategy.”
“The CIOs surveyed also suggested underperforming funds will likely take smaller, but higher conviction portfolio positions to pass the test. This may increase the overall risk within the portfolio, creating an unintended incentive for funds that have failed the test once.”
The march to passive will also encompass fixed income, with benchmark aware bond solutions likely to become more popular, though the preference is still for strategies that can access a wide spectrum of securities across the fixed income universe (opportunities for outperformance also beckon in private debt, which is not included in the listed benchmark for bonds). CIOs are also wary of using opportunistic tactical asset allocation given the potential tracking error involved, but it’s still ” an option for funds that are underperforming.”
“CIOs have expressed an increased willingness to lock-in profits from asset class decisions over long-term uncertainty, despite accepting that it may hurt longer term returns,” the report says. “This will result in a lower propensity to bet against a fund’s strategic asset allocation to take advantage of market falls (“buying the dip”), where long-term investors can add significant value.”
“Note that the performance test also poses challenges to top-down processes such as currency hedging programs and overlay strategies that are not captured by any benchmarks, potentially creating tracking error while improving the overall risk profile of the product.”
And while ESG is expected to suffer under YFYS as a long-term investment objective collides with an inherently short-term performance test, the “overwhelming feedback in the industry is that ESG is here to stay.”
“YFYS is more likely to reduce the meaningful use of negative screens,” the report says. “However, ‘real’ ESG integration will be highly valued, and the demand for more granular ESG information and climate data (e.g. carbon footprint) will only increase.”
Conducted through NMG Consulting, the study encompassed interviews of investment staff across 14 medium and large public offer funds, representing more than one-third of the sector’s AUM.
“Although passive investing is known as an economical way to have market exposure while maintaining reasonable risk diversification, it also limits an investor’s ability to deliver returns beyond the benchmark,” said Andrew Creber, JPMAM ANZ CEO. “As such, we see combining the benefits of passive investing with high-conviction active management as a more efficient way of building a solid portfolio under the YFYS framework.”
